Stack up on Energy

InvesTech Market Analyst, long one of
the best newsletters around, has added some new features to its issues,
including sections focused on strategy, sector, and security analysis. In
his first such feature, editor Jim Stack focuses
on energy and his favored play in this area

"We believe there is
excellent profit potential in the energy sector. With this in mind, we
recently added Vanguard Energy to our stock portfolio, taking our energy sector
allocation to 18% of the portfolio–more than double that of the S&P 500, and our largest
portfolio weighting. Vanguard Energy Fund (VGENX) is our favored
mutual fund choice in the energy sector. Our bullish view is
based on the supply and demand dynamics that Wall Street seems
unwilling to accept. Strong commodity prices in the sector are
backed by a strengthening economy and continuing unrest in the Middle
East and Venezuela. The synchronized worldwide economic recovery and soaring
demand from China, coincident with a constrained supply picture, should keep
product prices from dropping significantly from today’s high
levels.

"Our attraction to this fund rests primarily in its low-risk profile and
valuation-based investment philosophy. The fund’s focus on large integrated oil firms goes a long way
in explaining its relative low-risk profile. Because of the integrated
operations of these mammoth entities, they have less exposure to the
fluctuations in oil and gas prices than narrowly focused exploration or energy
service firms. Also, the large integrated firms often pay substantial dividends,
which have historically provided greater share price stability than those
companies that pay little in the way of dividends. In addition, the portfolio
has avoided mining issues and invested a
substantial portion of the assets in foreign domiciled energy firms, which also
reduces volatility. Our analysis shows current share
prices on diversified, good-quality energy companies are in many instances
20%-50% below our estimations of their intrinsic values.

"We are
impressed with the fund managers’ attention to valuation. Its valuation
metrics such as p/e and price-to-book ratios, are lower than those
of other energy sector funds. S
imilar to most Vanguard offerings, the Energy Fund has a low-cost structure and an
experienced management team. Its expense ratio was
0.4%, vs. 1.73% for the average specialty natural resource fund. The three-person management team has an
average tenure of almost eight years vs. 4.6 years for the
category average.
Of course, all of these positive attributes would be
meaningless if the long-term performance record was not superior to the category
average. Based on 12/31/03 data, the fund’s one-, three-, and five-year performance figures
far surpassed the results of the S&P Energy Sector Indexes for similar
time periods. Its performance against other specialty-natural resource funds
has also been exceptionally good, ranking in the top 30% of the category
for the last three- and five-year
periods."